Understanding the Financial System and Money Functions
The Financial System: Functions of Money: Be the change accepted by everyone, unit of account, worth of goods, securities deposits to savings guarantee. Evolution of Money: Exchange: exchange of some goods for others, Be Money 2.1 skins, sun, spearheads, 2.2 precious metals: gold, silver, and copper. Currencies: value guaranteed by the state, Bills: bills that gave the banquet as a guarantee of deposits convertible into gold.
Money Currently Used: set of notes and coins in circulation in an economy undertaken by the central bank. Trust is money, not convertible into gold, but the EU is based on the confidence that it will be accepted by everyone. Money Bank: Joint deposits or term deposits for a short time located in the banking system. Creation Process of Bank Money:
1) The banks receive deposits from clients, 2) keep a portion as reserves (cash coefficient). 3) provide refunds to customers who request, 4) The loan requested is deposited in the banking system, 5) This repeats the cycle. Monetary Demand: Causes of the Need for Money (transaction, precautionary, speculative demand; to exploit future investment opportunities).
Variables Increasing the Demand for Money: Rising Incomes, Rising Prices: Money provokes shifts in the monetary demand curve, Interest Rate Decline: Money causes a movement along the demand curve of money. Financial System: set of institutions (banks, savings banks, insurance companies, stock markets) that allow contact with the agents who have excess money (savers) and those in need (investors).
Supply: The total supply of money in circulation includes monetary financial assets based on their liquidity and their influence on the demand for goods and services. Banks and Savings Banks Income: Commissions for conducting services, interest for loans, bank charges for maintenance staff, etc. The loan interest is interest paid by large deposits:
Classes of Bank Deposits: 1) Current accounts: it has a checkbook for checks, 2) Savings accounts: deposits in a bank book, 3) Term accounts: capital is immobilized for a period of time. Classes of Bank Loans: 1) Current Account: advances payments from the bank while not having a balance, 2) Credit Line: can avail of a variable amount as needed,
3) Commercial Discount: the collection of letters of credit, 4) Mortgage: the guarantee of a property, and 5) Personal Loan: guaranteed by present and future assets of a person. The Existence of the Stock Market Allows: 1) Large companies to have their own capital without time limits, 2) Investors to sell shares or deeds as needed. Investors Expect: 1) Collection of dividends (profits distributed among firm members),
2) Collection of gains (selling price higher than the purchase price). Interest Rate: 1) High interest rates lead investors to buy fixed-income products, 2) Low interest rates lead to buying riskier products and variable income investments. The Central Bank: Functions: 1) Responsible for monetary policy (control of money supply), 2) Control and inspection of private banks, 3) Emission of banknotes and coins,
4) Bank of the State: custody of state reserves, 5) Bank of Banks: loans to banks and their reserve management, 6) Currency Exchange: managing currency changes. Main Objective: The ECB aims for price stability under the inflation target of close to 2% over the medium term.
Secondary Objective: To support general economic policies that are compatible with price stability. Type of Monetary Policy: Restrictive Policies: reduce the quantity of money in circulation, which implies a rising interest rate in the money market. Instruments: 1) Adjusting the cash reserve ratio, 2) Increasing the official interest rate applied to central bank loans,
3) Open market operations: granting loans to banks by selling public debt securities (withdrawing money from the system). Effects: Halting inflation: decreasing aggregate demand: reducing illegal consumption and investment: lowering production and jobs. Expansionary Policy: Increasing the quantity of money in circulation entails lowering the interest rate in the money market. Instruments: 1) Reducing the cash reserve ratio, 2) Decreasing the official interest rate,
3) Open market operations: a) loans to banks, b) buying public debt securities (injecting money into the system). Effects: Preventing deflation (generalized decrease in prices), increasing aggregate demand, and boosting investment and consumption, leading to increased production and employment. CURRENCY: Foreign currency is used as a medium of international payment. Type: Currency is the price to be paid to acquire foreign currency.
Depreciation: When the currency of country X loses value against another currency. Such changes happen gradually. Appreciation: If the value of a currency increases against foreign currency, this change also happens gradually. In appreciation, the exchange rate decreases when the system is flexible. In depreciation, the exchange rate changes in a flexible system, and decreases in revaluation occur in a fixed system. Market of Exchange: Exchange of applicants: economic agents needing foreign currency for payments. Bidding of Currencies: Forex traders engage in operations with foreign entities (exporters of goods and services, foreign investors, etc.). Functioning of the Currency Market: Demand for exchange increases when the exchange rate is low, while supply increases when the exchange rate rises, and equilibrium is reached when supply equals demand.
Currency Exchange Market: Demand for currency increases for various reasons, including if the interest rate of a currency is low, or if the price level is low. If the income level of a country is high, the demand for that currency increases. Speculators may believe a currency will depreciate. The Supply of Currency: Increases for various reasons. If the interest rate of a currency is high, the demand for that currency increases.
If the price level is low, the demand for that currency increases. If the income level is low, the demand for that currency decreases. Speculators may believe a currency will appreciate. Types of Exchange Rate Policies: 1) Flexible Exchange Rate: the market operates freely, and supply and demand determine the exchange rate. The exchange rate increases when the currency depreciates, and decreases when the currency appreciates.
2) Fixed Exchange Rate: each state sets the value of its currency, and the state is responsible for maintaining the national currency’s value in the market. 3) Fixed Non-Convertible Exchange Rate: the state sets the value of each currency, maintaining its value in financial markets, but its currency is not accepted for international payments.
4) Fluctuation Bands: the state maintains a fixed exchange rate with fluctuation bands, where the central bank will sell its currency to lower its value if it depreciates, or buy its currency to increase its value.